The real genius of Apple: Tax avoidance

Scott Klinger

Apple has gone on a very public tax strike. Months after reporting the second-highest quarterly profits in U.S. history, America's favorite company is refusing to bring home more than $60 billion of offshore funds in protest of the taxes it would have to pay.

Apple paints its predicament as unfair. Yet Apple's funds did not build up offshore because its iPhones, iPads and Macs are so much more popular overseas than they are at home. Though more than two-thirds of its retail stores are in the United States and Apple sells more products in the U.S. than in any other nation, it reports to shareholders that it made 24 cents in pre-tax profit for every dollar of sales in the United States, compared to 36 cents profit on every dollar of sales abroad.

Apple's profit margins are so much lower in the U.S., and it has billions of dollars of cash piled up offshore, because Apple's accounting and tax staff is as clever as its engineers and product designers. They take some of their profits earned in the United States and through accounting hocus-pocus transform them into foreign profits that are not taxed in the U.S. until they are returned here.

Here's how these tax avoidance strategies work: Apple conducts the bulk of its product and research development in the United States. This work is done largely by engineers educated in U.S. schools, often using basic research that was funded by U.S. taxpayers. Apple then takes the patents earned by its U.S. labs and registers them offshore in tax haven nations that impose little or no taxes on income on royalties from patents and other intellectual property. When Apple sells an iPod or Mac, it charges a lot for the use of the patents, telling the IRS that without this intellectual property, the product would be virtually worthless. By doing this, Apple transfers much of the profit from each sale to the tax haven, while retaining the costs of research, advertising and management in the United States.

Apple's transfer pricing shenanigans are legal but have drawn criticism from tax justice advocates, particularly in Europe. Since then, Apple's tax disclosures have been far more opaque, making it impossible to discern whether the company has backed off from its aggressive tax management or whether it simply doesn't talk about it publicly anymore.

Tax haven abuse by corporations and individuals costs the U.S. Treasury $100 billion a year. One way to begin to solve this problem is to require improved corporate tax disclosure. If Apple's customers and other taxpayers could see that Apple was booking the largest share of its sales in the United States, while it booked most of its profits in Ireland, the Netherlands and other tax havens, it would provoke important and necessary discussions. Another means of stemming the abuse would be to treat foreign subsidiaries managed and controlled from America as U.S. operations for tax purposes, a change proposed bySen. Carl Levinin the new CUT Loopholes Act.

When companies like Apple aggressively avoid their fair share of taxes, they shift the tax bill to their customers and other taxpayers. In the 1950s, corporate income taxes accounted for nearly a third of total federal government receipts. Last year, corporate taxes accounted for less than 8 percent of Treasury receipts, an all-time low.

The deficits that result from corporate tax avoidance have increased pressure for the government to cut spending, including spending on the very sort of basic research without which Apple, Google and Microsoft would not exist. The first modern computers and the Internet were not invented by people named Jobs, Wozniak, Hewlett, Packard or Gates, but by unsung scientists working on government-funded research, paid for by taxpayers. That taxpayer-funded government support continues today: Google co-founder Sergei Brin, for example, received a National Science Foundation graduate research fellowship promoting digital libraries while laying the foundation for what would become Google.

Apple's tax strike is shortsighted. By denying the government tax revenues, Apple is refusing to help plant the seeds from which the next great technological innovations will grow.